Does the ‘4% Rule’ Make Sense for Doctors?

The “4% rule” is nearly universal in the personal finance space. My goal here is to explain the 4% rule and its origins, while also examining if the rule still holds up — especially for doctors.

So, how much of your retirement savings can you take out for living expenses each year in retirement without running out of money? That is the question that the 4% rule tries to answer.

And it’s actually the biggest piece of the puzzle to estimating how much of a nest egg you will actually need to reach “financial independence” and “retire early” (FIRE).

Well, the answer to the question is the 4% rule. It says that if you draw down 4% of your retirement savings each year during retirement, your nest egg will have the best chance of living as long as you do. This means you will not run out of money before you die.

You withdraw 4% per year and the rest of the money is working for you in your investments to keep replenishing so that you have enough for the golden years.

People are usually surprised at this concept as they imagined they would be able to withdraw a higher amount per year – I know I was! (Note that the 4% rule is important not just in retirement but before retirement. That’s because it provides a guide to estimating how much of a nest egg you need to retire. The number may be higher than you expect!) The good news is that as physicians, our income is typically high enough that we can create a savings rate that will get us to our goals through wise investing in broadly diversified, low cost index funds.

Now that we have a good sense of what the 4% rule is and why it is important, let’s examine its origin…

The 4% Rule Origin Story

The creator of the 4% rule is a guy named Bill Bengen. He was a soft drink executive who later got a master’s degree in finance and started a financial planning firm. Bengen is really smart — like got his degree in aeronautics from MIT smart. When he opened his firm, the prevailing logic was that, if the market return from the overall stock market was around 7%, then that was how much retirees could withdraw from their nest egg each year.

This math didn’t work for Bengen. So, as Paula Pant shared in a recent podcast, he studied every possible 30-year retirement window in American markets, kicking off in 1926. Window one: 1926-1955. Window two: 1927-1956. And on and on.

For each window, he used a simple model portfolio asset allocation of 50% S&P 500 and 50% medium-term government bonds. He then determined, in the worst possible market conditions in history — the real worst-case scenario — what could a retiree safely take from their nest egg?

His calculations revealed a magic number: 4.15%.

So, a retiree could withdraw that much in the first year of their retirement. Then take that same amount each year after, bumped up for inflation. And, based on Bengen’s study, even in the worst markets, the money would last.

Does the 4% Rule Hold Up?

The 4% rule has its fair share of critics. Mainly because they think it’s too conservative. And they are right — but it’s by design. Because it assumes three things:

• That you will live a very, very long time
• That you will retire in the worst market conditions possible
• Your expenses are completely fixed

The probability of all things happening is low. Most people will not retire in the Great Depression and live to be 115. And expenses are never quite fixed. But, if that did happen to you, the 4% rule would keep you financially safe. And that is a reassuring thing.

That is how the 4% rule works in a vacuum.

But How Does It Work in Real Life?

The factor most critics cite in railing against the 4% rule is sequence of returns, which refers to the individual yearly returns of the stock market rather than its overall average. For example, average yearly returns for 3 sample years could be 5.33%. But the sequence of returns could be 1%, 10%, and 5%. Or it could be 10%, 5%, and 1%. Two different sequence of returns, same average.

The issue becomes that some sequences of returns are better than others. In the simplest terms, the higher the returns early in your retirement, the better. The lower the returns early on, the worse. That’s because you would be forced to sell stocks (to cover your retirement living expenses) while stocks were at a low.

The 4% rule assumes the worst. But that is usually not the case. Taking it from Bengen himself, a better rule may be the 5% withdrawal rule!

What Does This Mean for Doctors?

For doctors, the 5% rule probably makes even more sense. My reasoning is that we maintain very high and flexible earning potential.

So, let’s say that, as a doctor, I retire and follow the 5% rule. But then, of course, the worst-case scenario happens: markets crash, skies are falling. And I realize that I will actually be a little short on retirement funds if I live a very, very long time. Well, thankfully I am a doctor. I could always go back to clinical medicine in some capacity and make a bunch more money. Or I could pursue any alternative medical career or side gig and be well-compensated. We are lucky to have a nice parachute!

What Do I Do?

I’ll tell you exactly what I do and plan to do: I’m going to keep using the 4% rule!

Why?

Well, I am on the more conservative side. To put things in a different perspective, I was always the type of person that believed if I was 15 minutes ahead of time, I was on time. And if I was on time, I was late. That way, I was never actually late. Worst-case scenario, I was on time.

The 4% rule is the same thing for money. By following it, in the best-case scenario, I have a lot more money to spend than I anticipated. And worst-case scenario, we are still A-OK. That’s why I use the 4% rule to estimate my goal nest egg. I believe most doctors, as high-income earners, have the luxury to do the same thing.

Please enable JavaScript to view the comments powered by Disqus.